Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $800,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following. Sales revenue Direct materials Direct labor Chairs $1,150,000 584,000 160,000 Desks $2,105,000 300,000 340,000 Required: a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks. a-2. Which of the two products should be dropped? b. Regardless of your answer in requirement (a) the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $650,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2?

Answer 1

Calculation of profit margin
	Chair	Desk
Sales revenue	1150000	2105000
less: cost of product:
direct material	584000	800000
direct labor	160000	340000
manufacturing overhead	256000	544000
total cost of product	1000000	1684000
product gross profit	150000	421000
profit margin	15%	25%
Manufacturing overhead = (800000*160000/500000)
Chair = 256000
desk = (800000*340000/500000) = 544000
a-2)chair should dropped because of profit margin is less than
expected that is 20%
b)	Desk
Sales revenue	2105000
less: cost of product:
direct material	800000
direct labor	340000
manufacturing overhead	650000
Total cost of product	1790000
product gross profit	315000
estimated margin for desk	17.6%
Profit margin = product gross profit/total cost of product